Kentucky’s finances received a blow late Thursday after Standard & Poor’s rating service downgraded the commonwealth’s outlook to negative from stable.

The downgrade came largely because of the state’s unfunded pension liability.

"The outlook revision reflects our concern over pension funded levels, which have declined and are likely to continue declining due to lower-than-actuarially required funding of pension liabilities, and budgetary pressures associated with funding post-retirement benefits," said Standard & Poor's credit analyst John Sugden.

Kentucky retains its 'AA-' issuer credit rating based on its healthy recovery, moderate debt burden and conservative revenue forecasting, S&P said in a release.

Standard & Poor's also assigned its 'A+' long-term rating, with a negative outlook, to Kentucky Asset Liability Commission, which is part of Kentucky’s Finance and Administration Cabinet. On Jan. 14, the commission authorized the issuance of the notes, largely to pay for $152.4 million of the state’s share of the healthcare benefit contributions to the state pension’s medical insurance trust fund for fiscal 2013 and 2014.

“In our view, the financing represents bonding to fund operating costs related to providing post-retirement healthcare benefits during the current biennium and therefore constitute deficit financings on behalf of Kentucky,” S&P said.

The report added that “there is no clear timeline on when the state legislature will consider” recommendations from the Kentucky Pension Task Force on how to improve the state's pension funding status. “And even if the legislature adopts some of the recommendations, it's unclear when the changes would take effect, especially if these reform efforts face legal challenges,” the report added.

In mid January, Standard & Poor's downgraded Illinois’s debt rating based largely on the state’s failure to pass pension reform in the legislative session that ended in early January. This week, Illinois announced it was delaying plans to borrow $500 million in light of its downgrade.

At Governing’s Outlook in the States and Localities conference held earlier this week in Washington, D.C., Sugden predicted that pensions and unfunded liabilities would have more of an impact on states’ and localities’ ratings this year.

“Underfunding ... or where there isn’t sufficient action on pension reform, it has affected our view of the credit negatively,” he said.